Back in my uni days, I needed a foil to the dry study of finance and accounting. So I did Shakespearian tragedies to Stage 3. Since the main driver of finance is human behaviour, I’d have to say I learnt more from these tragedies than I did Financial Accounting.
One of my favourite pieces of literature is King Lear. Simple but moving story. The old king gets tired of the responsibility for all his assets. So he aims to pass them on to his three daughters — Goneril, Regan and Cordelia — if they promise their undying love for him.
Cordelia, his youngest daughter, won’t promise love beyond her husband. Old Dad gets mad and cuts her off.
That leaves Goneril and Regan as the sole beneficiaries of the king’s fortune. They promise him their undying love. But, alas, there’s no happy ending here.
The dramatic lesson
Long story made short, Dad ends up homeless and with nothing. He’s thrown out on to the stormy moors by the daughters who promised him everything.
The king goes mad. Proclaiming in wisdom clutched from desperation, ‘Nothing will come from nothing.’
That’s the theme of the play…
You will gain nothing if you invest nothing
It’s not only a lesson for parents and kings. It’s a lesson for anyone wanting to maximise their wealth.
Fail to invest at all — or fail to invest well — and you’ll end up with little.
Now, what I want to address is that many people don’t invest in stocks because they perceive them as risky.
It’s true, when you buy shares, you’re buying into a business. Businesses, by nature, carry risks. There are no zero-risk stocks.
But if you want to enjoy the growth that businesses can deliver, you may need to take those risks.
In a moment, I’ll share with you one key yardstick I use to manage and even reduce my risks when investing in shares.
The question we keep getting — isn’t property lower risk than shares?
The big advantage of property is you obtain real physical assets and can leverage them. But you sacrifice the passive nature of holding stocks. This is because most property requires costly and time-consuming management and maintenance.
I conducted my own real-world test. In 2012, I sold a rental property and put the proceeds into shares.
- For capital growth, the rise has been very similar.
- Dividends have given a better yield than net rent.
- In both cases, leverage of around 45% has been available to me.
Yet the enduring factor is that the shares have taken less of a toll on the stress front. You keep abreast of the companies, reports and analysis. Dividends are automatic. There’s no chasing up rent. Dealing with tricky tenants. Or the endless woes of accommodating people whose interest in your asset is unaligned.
Mind you, some people thrive on this. They become skilled landlords.
Not me. Emails from tenants or property managers inevitably felt like boils awaiting lancing.
Reducing the investing risk of shares
You could pay a financial adviser or fund manager with a proven track record to assist you in researching the best companies to invest in.
You can also analyse your own shares.
When it comes to reducing risk, one consideration you have to look into is the assets you’re actually buying — and at what price.
There’s a simple shortcut ratio called Price to Book — or P/B.
Let me give you an example.
Auckland International Airport [NZX:AIA] at time of writing, trades on a P/B of about 1.8.
A P/B of 1 would mean that when you buy the share, you’re paying the actual value of the assets.
1.8 means you’re paying an 80% premium to own the airport’s assets.
Finding a solid balance sheet to invest in
Of course, you need to check on the balance sheet what the assets encompass. Some business assets include large amounts of intangibles — brands, goodwill, websites and assets that are not readily saleable outside of the business.
If you want to reduce risk, you should discount these and concentrate on the Price to Book value on tangible assets.
In the case of Auckland Airport, most of the assets are pretty tangible. Significant land holdings. Airport terminals. Car parking.
So, in that case, an 80% premium does not appear to present a very high risk. But better still would be the opportunity to buy the shares when they are priced below the book value. Especially in the case of companies whose valuation is made up of property assets.
This is something we’re targeting in our premium research newsletter — Lifetime Wealth Investor. Price to Book bargains that can help you manage the risk of your investing — and maximise your returns as asset values rise.
Invest well in something. Not just any old thing. Something that can deliver income and growth.
Simon Angelo owns shares in Auckland International Airport [NZX:AIA] via Wealth Manager Vistafolio.